Investing in real estate, otherwise known as bricks and mortar, has become a very popular choice for many people over the past decade, but many people considering this investment option do not really consider all of the potential problems with real estate before making the leap to purchase. While real estate can be a good investment for some people, it is important to consider how much money you can afford to allocate to this investment, its real return over time, and its maintenance costs.
One of the big problems with investing in real estate is that it requires a large amount of capital. Finding a single family home for less than $100,000 is next to impossible in most areas of the country, and multi-family residences are hard to come by for less than $500,000. For the vast majority of people, purchasing real estate means placing over half of their total portfolio in one investment, or taking on so much new debt that they become insolvent. Either way, a person is opening themselves up to a lot of risk by placing so much money into a single asset. By doing this, a variety of small disasters could potentially wipe out most of their portfolio and leave them destitute.
Another common mistake that too many people make when considering an investment in real estate is overestimating the return on their investment. In general, there are two ways to actually make money from of real estate; renting out the property and selling the property.
Renting out real estate is more complicated than collecting the rent check every month, despite what many realtors may tell you. To start, it is necessary to find a property that makes a good rental unit. This does not necessary mean finding a property that makes a good primary residence. Good rental properties are in good repair (so as to lower the owner’s maintenance costs), are close to schools and businesses (since most renters do not want long commutes), have a small amount of yard (to reduce upkeep), and are able to retain their value well.
Once a suitable property is found, it is critical to run a cost-benefit analysis using realistic numbers. Assuming a 90% occupancy rate (that is, the property is occupied and earning rent nine out of every ten months) is considered a moderate estimate. Furthermore, it is crucial to find recent and accurate rental amounts for comparable properties. After doing this, it is also necessary to factor in insurance, property taxes, and property management costs.
After doing this analysis, many people discover that they are barely breaking even or losing money on their real estate investment every month. Nonetheless, many people go ahead with the purchase, assuming that when they sell the property they will make a good return on their investment. Unfortunately, this is rarely the case.
Historically, the average piece of real estate has appreciated 2% a year. While there have certainly been years that have outperformed this rate, there have also been years where real estate values have fallen. Furthermore, few people consider how much having renters in a property will depreciate that property. Tenants rarely add value to a property they are renting. Instead, many landlords discover that they are content to let the yard go to seed and cause minor damage to the interior of a property. Selling the property without investing money into its rehab can result in a loss of thousands of dollars.